A CHANGING LANDSCAPE
Sub-custodians are finding new ways to serve their clients as the shape of the post-crisis landscape becomes clearer.
Moderated by Joseph Giarraputo
Global Finance: What are the latest technology developments we should be aware of, and what changes will technology bring in the near future?
Alan Cameron, head of clearing, settlement and custody, BNP Paribas: Technology has helped transform the scale with which we do things throughout transaction banking. It has increased capacity and reliability whilst reducing costs. These will be the main trends for the future: more of the same on a bigger scale.
Ulf Noren, global head of sub-custody client relations, SEB: During the past few years a lot of the development has been on the trading side, with fast and smart, lower latency methodologies coming up. Now, development is connected to increasing operational efficiency, lowering costs and so on.
Alistair Jones, head of sales and relationship management Europe, sub-custody and clearing, HSBC Securities Services, HSBC: In order to handle newly developed products, harmonization of systems within an organization is essential. We have already started to consolidate systems in order to improve overall efficiency, to decrease our running costs and to make things more standard globally so that we can quickly and easily add new products as they come to the market, no matter where in our global network.
Satvinder S. Singh, managing director and head of direct custody and clearing EMEA, Citi: Technology is changing our business. Technology has enabled sell-side institutions to develop innovative solutions to tap into the fragmented pools of liquidity across Europe. Algorithmic trading models, high-frequency and program traders are accessing new MTFs and dark pools in the pursuit of cheaper, faster and low-market-impact trading. Firms have had to adjust their post-trade models to enable access to multi-market trading platforms and CCPs. Further upgrades in technology will allow firms to provide more integrated or end-to-end solutions to clients. Custodians need to focus on their ability to support this high-volume business. We have, and continue to make, significant investments in technology. In addition, this impact of technology has a significant knock-on impact in terms of new client segments, new credit policies, work with the regulators, etc. From a client perspective, one of the key areas is resilience of the sub-custodian.
Cameron: Another area in which rapid improvements have occurred is the ability to pull information together to make decisions. That has been very important during the financial crisis. If you look back, say, 15 years, assessing your position around the world could literally take days—as you were dependent upon sending messages backwards and forwards.
Noren: There are still some rather old system parts around as well, though. Replacing some of those should be a priority.
Jones: We can’t ignore the impact of technology on many of the frontier markets. Where their settlement infrastructure might have been physical in the past, they’ve now become dematerialized, which has enabled the custody space to become more efficient.
GF: As sub-custodians, you have the global custodians’ technology demands on one side and the markets’ on the other. Who calls the shots?
Singh: It’s a balance. A certain portion of your technology spend relates to changes that are happening in the market. Another part goes to new initiatives you are proactively trying to implement. This may be client-driven, or arise from a market-driven product opportunity. We are spending increasing amounts on proactive initiatives that help provide added-value services to our clients.
Cameron: This huge investment in technology has really shaped the players in the industry and determined who has survived. That will continue and perhaps even intensify.
GF: The financial crisis has heightened financial market participants’ awareness of risk. How has this affected sub-custodians’ relationship with their clients, and how do sub-custodians measure risk and treat it?
Singh: Financial institutions have taken a back-to-basics approach with market, counterparty, credit and operational risk, reassessing core assumptions including a review of contracts with clients. The risk of a counterparty failing has had to be reconsidered after the Lehman collapse. Another risk that had been previously overlooked is settlement risk. This has gained importance and is particularly pertinent for agent banks that provide cash management and securities services to clients. Such services require significant intraday credit lines, which expose the agent bank to settlement risk. This is not consistent across the markets, and custodians have had to look at better ways to support settlement risk mitigation through more robust documentation or via collateralized lending.
Noren: Finding, measuring and understanding what kind of exposure we have is crucial. But that is not all; it’s important to interpret the consequences of an exposure. There is a widespread opinion that any level of risk can be tolerated as long as it’s either regulated or pushed onto someone else. But we think that we are building an extremely complicated Europe in this new space, with risks more or less everywhere. Together, we have a shot at addressing that situation, and we should, because it’s of crucial importance that this industry regains some control over that element. Since the beginning of the 2000s, that control has shifted to the regulators.
Jones: While we’re not really doing anything significantly different to how we were doing it before, there’s pressure to be able to pull the data together much more expediently than before. Things happen so quickly, you’ve got to have that data now, to be able to maintain control and to make the appropriate risk decisions.
Cameron: The financial crisis has increased focus on credit risk. Of course agent banks have been concerned to ensure that they get back the money they have lent. But those using agent banks have another perspective: They have become much more aware of the risk that they have when leaving money or securities with a bank. But how do sub-custodians measure risk and treat it? Well, with great difficulty; it is a complicated subject. Risk measurement varies from market to market, from instrument to instrument, from contract to contract. And the challenge is to amass all of this information and come up with a number where one can say, “This is our credit exposure to the client.” In the past banks have tended to bank balance sheets—but the industry, to an extent, is moving towards banking the transaction flow. Where the transactions are, what your rights are, under what contract—these are questions of importance when determining credit risk.
Cameron joined BNP Paribas in 2008. His current role is leading the clearing, settlement and custody business on a global basis. He is a member of the BNP Paribas Securities Services Management Comex. Cameron has over 25 years’ experience in financial services, in various senior management positions, primarily within the securities services environment. Prior to joining BNP Paribas, Cameron worked for Citi’s Global Transaction Banking division, undertaking a number of different management roles in sales, relationship management and product management. He is a graduate of the University of Edinburgh and an associate of the Chartered Institute of Bankers in Scotland.
GF: Does the intensified focus on risk evaluation have cost implications for sub-custodians?
Noren: It has a huge impact and leads to an interesting question as to who really has to pay for this increased focus
Singh: Clients have really appreciated an open book policy when explaining risk. The time spent on explaining risk has risen dramatically, but these discussions are critical given the new environment in which we are operating. As a custodian, being able to explain what is happening across a range of markets, including regulatory change and its impact, is very important.
Jones: The crisis also impacted some of the products that, in the past, were in demand by clients. We have to make sure we understand the risk in those products—especially when you do contractual settlement on corporate actions. Everyone wants to make sure that they fully understand everything, front to back, and that they’re being properly compensated for the risk that they’re undertaking.
HSBC Securities Services
HSBC Securities Services
Jones is the head of sales and relationship management Europe for HSBC’s sub-custody and clearing business, which operates in 39 markets. He is a member of the BBA Custody Advisory Panel and an active member of various trade associations. Prior to joining HSBC, Jones was global head of network management at ABN AMRO. Before that, he worked in a variety of senior roles at Dresdner Kleinwort, Deutsche Bank and Goldman Sachs and has lived and worked in places such as Frankfurt, Hong Kong and New York.
GF: What other impact has the financial crisis had on sub-custodians?
Jones: In some ways it’s created an uneven playing field with a number of institutions receiving financial support from governments. That has distorted the opinion some customers may have of the risks of a custodian—particularly some single-market providers—and may have given them a competitive advantage. Volatility has also had an impact. We’ve seen asset values decrease tremendously, which is where a large amount of revenue is derived. The transaction volumes have remained healthy generally, though.
Noren: Most of the sub-custodians already have really good cost control so there is not much room to reduce the cost basis. But three out of four major revenue sources have dropped significantly. The measures taken as a result of the crisis may have reduced big risks to a great extent, but they certainly have reduced revenues, too. Also, in the wake of the crisis, clients have been hunting for cost reductions and efficiency increases, and one of the things they’re doing is asking for fee reductions.
Cameron: Firstly, throughout the transaction banking industry there is a mismatch between revenue drivers and costs. This has been highlighted by the extreme market conditions that resulted from the financial crisis. This is true for many players, not just agent banks. Secondly, the crisis has accelerated the consolidation of custodians and clients. Thirdly, there is a heightened awareness of the importance of collateral. Knowing what you can get when things get tough has become very important to the whole industry.
Singh: For sub-custodians the past 18 months have been fundamentally challenging from a P&L perspective. There is a drive to create greater efficiencies throughout the securities life cycle. Strategically, as an industry, we have to respond to shifts in client behavior. I believe we are seeing shifts, such as a flight to quality. Clients are concerned about smaller, one-country or smaller regional providers versus large global banks that have reaffirmed the commitment to the transactional banking business. Clients are less focused on opening new markets and, rather, looking at their own expense base because they are equally impacted by the headwinds that we are facing. They are considering where they can move to a variable cost base by outsourcing more pieces of the business to the sub-custodian. From a sub-custodian perspective, can we move up the value chain? Can we change the way we view our business and our products, creating open architecture, such as providing asset servicing only? This is strategically the right thing to do. Organizations that have really spent time on the strategic opportunities presented by the change will really benefit from this.
GF: How will regulatory changes on the horizon affect sub-custodians?
Cameron: I’m not sure there will be regulatory changes, but there are two areas where we will probably see market pressure to change; both are tied up with the drive to reduce risk generally in the marketplace. First would be the shortening of the settlement cycle, as that would reduce pre-settlement risk. Second would be putting more over-the-counter [OTC] transactions into central counterparties [CCPs.] Currently, OTC transactions live by themselves, often unmargined, sometimes inconsistently measured, so I think we’ll see a lot of effort to have more OTC transactions cleared through the CCPs.
Noren: There may be legislation relating to interoperability of CCPs. The regulators are concerned that industry is not fully engaged with the current code of conduct, which is voluntary, and they’re saying: “Fine, we have let the industry do what it could; we’ve reached an impasse. We will come in and provide the legislative framework to move the industry.” That may actually present opportunities for the industry. In Europe, there’s T2S [the European Central Bank’s proposal for an integrated securities settlement system], which fundamentally changes the settlement side of what we do. That again is a huge opportunity for the industry. Clearly, current revenues are under threat, but it gives us a great opportunity to redefine ourselves. In the European landscape you have the exchange, the CCP, the central securities depository (CSD), the sub-custodian and the global custodian. Most of these entities have defined roles and responsibilities, but there’s a degree of overlap. That overlap is going to be significant in a post-T2S world, and all the players will have the opportunity to reinvent themselves. If you’re strategically clear as to the role that you, as an organization, want to play, there is absolutely a role there for us. The role will change, but it’s still as relevant, if not more relevant, than it is today.
Jones: We’d be happy to see more harmonization taking place in the way certain transactions are settled, the way corporate events are processed, especially in Europe, and in other parts of the world too. We’d all have to change our behavior, whatever the settlement cycle is, and ensure that the market, or that location, is still attractive to investors all round the world, whether it’s a T plus zero, or T plus something settlement cycle, to make sure that all the post-trading activities—for example, the account allocations, the settlement instructions, the pre-matching—can all take place. Any changes have to be very controlled, and different locations around the world will be able to move at a different speed, for different reasons.
Singh: A new directive, informally referred to as European Market Infrastructure Legislation [EMIL], is expected to materialize in 2010 focusing on [OTC] derivatives, CCP risk and governance standards. CCP interoperability for cash equities will potentially be included in this legislative measure to complement the Code of Conduct on Clearing and Settlement. T2S will commence development phase in 2010. These initiatives will have a fundamental impact on how industry participants will conduct business in Europe. An important point to note is we need to achieve proper regulation, not over-regulation. None of us are against regulation as long as it supports the industry, does not kill innovation and improves risk management.
GF: In most countries, clients may choose from several competing sub-custodians. How do clients make their choices, and what do they value in sub-custodians?
Cameron: Firstly, the appointment of a sub-custodian is a credit relationship. Can the bank provide the credit required, and is the client happy with the credit standing of the sub-custodian? These are prerequisites. After that, clients will look at how you transact in the market. They are certainly interested in you having a broad range of services and a sustainable business. They will be interested in how you can display your knowledge of what is happening in the market and what will happen in the market in the future. Wrapping all that up is how you bundle all these different points into a service to the client.
Singh: There are three traditional buying criteria: price, service and relationship. Over the past few years we have added two more factors: commitment and thought leadership. Especially after the Lehman crisis, it is very important for clients to know their provider is committed to a market, committed to the business, expanding their product range and value-added services, and most importantly committed to them as a client. Thought leadership and market advocacy is also important. A lot of our clients value this highly—for example, what we deliver around a roundtable like this, our views on the industry. Clients value those sub-custodians who provide thought leadership, can articulate the impact of market changes, and who truly understand their business and how to tailor products and solutions to help them cope with this change.
Noren: Sub-custodian appointments are increasingly made as a strategy decision. As a sub-custodian, you only deal with a professional client base, and they, of course, have their views on how the world is going to develop. If your interpretation aligns with theirs, you get the vote. On top of that come all these other things: the foundation of your business, the quality and, perhaps most important, the sub-custodian’s commitment to the business. No client wants to find that their preferred service provider is suddenly pulling out of this space.
Jones: Clients are increasingly looking for a partnership, where they work more closely with us. Certainly in the markets that they might not understand in as much detail, they’ll be looking for leadership, and more active involvement with a custodian in market advocacy, where they may be petitioning the local regulator or the exchange, to make changes in that settlement environment. That is a key factor that clients will consider. Also, a number of our clients are now looking for regional solutions rather than single country solutions. Potential clients also want to know what value-added services you can add as a group, outside of just being a custodian. “Can you do the foreign exchange? Are you a member of the local central bank? Can you do brokerage? Can you do trade execution for the clients as well?” We try to be the eyes and ears on the ground for our customers, to be the world’s local bank. And really we’re trying to shield our customers from as many of the difficulties in those markets, to try and make it more standard, wherever possible. Clients investing in 100 or more markets have to remain an expert in all of them. They look to their custodian to help them, to work with them and to ensure that they don’t fall foul of any regulations in this fast-changing environment.
“In most countries, clients may choose from several competing sub-custodians”
GF: Some sub-custodians have regional rather than global reach. How are these organizations differentiating the services they provide from banks indigenous to a country?
Jones: When they’re dealing with us as a custodian, clients want a consistent approach across all countries. They want the account opening, billing and the quality of reporting to be standardized and the people they’re talking to, to be very knowledgeable and responsive, so they can leverage the relationships and they don’t have to go through various Internet portals and research from different providers. So, as much as possible, it should be plug-and-play as quickly as possible so that everything settles down quickly, the Swift messages can be sent and they can be read effectively. Clients don’t want to have to fine-tune each time they go into a new market for a new account.
Noren: Adding onto that, you do assume regional and global players will give you an aggressive geographical reach. And you can also add on the regional best practice to be implemented in the respective local markets serviced. Clients can also, up to the point where it’s possible, reduce the legal and documentary hassle, as a regional provider should be able to harmonize across different markets. And then you, of course, have the cost and efficiency gains that follow from adding more volume to the table.
Singh: Having a sub-custody network in 57 markets globally and 31 markets in EMEA helps reinforce to the market our commitment to this business. Expanding our network and product range shows commitment and desire to invest in this business. Given the discussion we have just had about technology and the need to invest, a global player is more able to effectively leverage the spend on systems, product development and thought leadership. For example, Citi is replicating solutions in Europe, such as third-party clearing, in Asia-Pacific. The leadership Citi has demonstrated in Europe in providing innovative services for market infrastructures is now being replicated in Asia, Latin America and so on. Global organizations can only be more successful than regional or single-market providers if we can ensure transfer of best practice between countries. This is fundamental, and at Citi we spend a lot of time ensuring global consistency and that knowledge and skills transfer takes place. Also, servicing a client globally or in multi-markets gives you much better insight into what they want and how we can add value.
Cameron: It varies dramatically from region to region, and indeed from sub-region to sub-region. Sometimes there are markets literally next to each other where there is little in common, and providing a service in both really only gives economies of scale in technology, etc. But in Europe it’s very different, as we now have some pan-regional infrastructures, so being regional is more or less essential nowadays. That is not the case on other regions.
GF: How do indigenous country custodians present their case?
Cameron: There are very few indigenous single-market custodians left, and those that are there are getting gradually squeezed out. It’s really because of this huge investment in technology. The more transactions you can spread your technology investment over, then the better it is. And to get that number of transactions, you have to be in a large number of markets.
Singh: From a client perspective, as well, post-Lehman there is more reluctance to remain with one-market or two-market providers. Clients feel a lot more comfortable dealing with a large organization, given it is a much bigger relationship, and they know that commitment levels are generally much higher.
Jones: Regulators often look to the local banks to work with them more closely when an idea or a change is being debated. They will look to discuss with us the experience that we’ve had where something similar has taken place elsewhere. They’ll want to learn from our experience, what could be done better. So again, as local providers or global providers, we have an ability to offer leadership where a single-market provider might not have the same experience. For both clients and regulators, there’s huge pressure to implement things as quickly as possible. Through our experience in other locations, we can help the expediency—and the quality—of delivery.
Noren: That’s a trend we see, too, and possibly also the last fortress of the single-market provider, namely influence. So even the market influence is going. The regulators go to the regional or global carriers rather than going to the single-market provider.
Noren has worked with both global custody and sub-custody for more than 26 years. He is mainly working in the sub-custody field, being responsible for the client relations and sales force in this business for SEB’s operations in Denmark, Estonia, Finland, Germany, Latvia, Lithuania, Norway, Sweden, Russia and Ukraine. SEB puts a great deal of focus on building and refining the regionalized Nordic/Baltic service concept, on its strictly one-market relationships, on combinations within the Nordic countries, the regionalized Baltics or combinations within CEE. Also Noren represents SEB within several industry groups, locally, regionally and EU-wide.
GF: New approaches to clearing are being developed around the world. What’s happening in this regard?
Singh: Europe is frequently compared unfavorably with the US when it comes to clearing and settlement, particularly with regard to cost. The US model, based on a single CSD, the DTCC, delivers much lower clearing and settlement fees. Five main clearing houses are competing for business in Europe, leading to speculation that the market will consolidate. CCPs are very much flavor of the month, attracting attention at the highest echelons of government and regulatory bodies. In the US, Europe and Japan, CCPs are being developed for the OTC derivatives markets. The clamor for greater interoperability between CCPs is likely to continue. A framework agreement would require CCPs to agree on risk management arrangements that are transparent to market users, platforms and regulators. Progress has been slow as there has been insufficient transparency in how new risks caused by interoperability are managed.
Cameron: Third-party clearing in Asia is an important development. In Europe, we provide our clients with a simple access to a complicated infrastructure. I think there are 17 CCPs in Europe, so we need interoperability. A multilateral approach must be the way ahead for CCPs. Setting up bilateral interoperability may be quick in the short term, but in the long term it may become unsustainable. Europe needs a multilateral solution; even if it takes longer to get going in the first place, it will be worth it in the long run. When interoperability takes-off, we will all have to make some very important decisions as to which CCPs to use, but for now the key focus of the agent banks is to maintain the broad access that we offer clients and keep all options open.
Jones: In the markets where there are central counterparties, a number of new products will be considered, or should be considered, to be admitted for clearance. But in some markets, central counterparties are highly unlikely to be implemented—perhaps in some of the Middle Eastern markets—because there are different restrictions there, such as shorter settlement cycles or beneficial ownership markets. It’s also unclear how Latin America will go forward, so I don’t think we’ll have one harmonious global trading platform. One thing I do hope is that, as new instruments become eligible for clearing, they will use existing central counterparties for clearing rather than creating yet more CCPs.
Noren: We believe the competitive trading environment will continue to develop, and we also believe that we will see more trading platforms rather than fewer in the short term. With them will also, I’m afraid, follow some more CCPs. Ultimately, though we may need to deal with new CCPs in the short term, with interoperability there will be consolidation of the clearing processes, which will reduce the number of central counterparties in the long term.
Jones: With the number of central counterparties we have today, there’s a huge cost in keeping the interoperability up to date. Every time there’s a change, be it mandatory or discretionary or a value-added service introduced, the spaghetti junction will have to be retested. How that will happen, who will drive it, the costs associated with this are all unknown currently, and it could be an operational and risk nightmare.
Satvinder S. Singh
Citi Global Transaction Services
Satvinder S. Singh
Citi Global Transaction Services
Singh is managing director and head of direct custody and clearing business for Citi’s Global Transaction Services across Europe, the Middle East and Africa. He joined Citi in January 2008 after 14 years with HSBC, where he was most recently global head of sales and relationship management for the direct clearing and custody business. Singh’s experience at HSBC included various roles in the direct clearing and custody business across multiple geographies, including India and Hong Kong. He holds an MBA from Durham University, United Kingdom, and a bachelor of engineering from Delhi College of Engineering, India. Throughout his education, Singh lived in Malawi, Belgium, Lebanon, Bulgaria, Burma, Italy and the United Kingdom.
GF: What new financial products or existing products in new markets are custodians working on?
Cameron: We’re expanding the network of our local custody and clearance capabilities. We’re opening in key markets in Eastern Europe and North Africa, and we have a commitment to expand into Asia, where we’ve opened up in Hong Kong, Singapore and India. We also have product expansion, particularly to deal with new client segments. We’re now dealing more with mid-tier players, and their demands are slightly different, so we are focusing on outsourcing and third-party clearing. Another area we’re investing heavily in is derivatives.
Singh: We already have extensive coverage globally, having expanded our proprietary custody network geographically over the past decade. We continue to focus on the Middle East because we think there is huge potential for competition to come in and add value. In terms of product expansion, we are trying to make operating in Europe more efficient for our clients by providing them with services that allow them the flexibility to position their business for how Europe may look in two or three years from now. Making products available today that cater to a changing European clearing and settlement landscape is extremely important. We have also been transferring our third-party clearing expertise to other regions, such as Asia-Pacific, as regulations change and open up. We are already seeing pioneering transactions in Asia being awarded to us based on our skill set and the expertise we have demonstrated in this segment in Europe.
Noren: Like most of our regional peers, we are developing our product offering in a number of ways. One is geographical dimension: We’ll invest in growing our geographical presence. We need to manifest our presence in Germany, Russia and Ukraine—and our view of Europe dictates that we need to increase our geographical presence across the continent. There are various ways of achieving that, and that’s something that we will focus a lot on. A second area is on the product side, where the most important investments will go into asset servicing products, tax products and risk mitigation, especially within the area of clearing where, due to our history, we are in a very fast growth phase. We invested a lot of funds into that space. The third part is more on the soft side, where we will keep investing in FTEs and capital to acquire more customers. We will also focus a lot more on providing emerging markets support. The markets that we service in emerging Europe are very diverse, with one large market, which is Russia, and one market with the potential to become large, although in capital and many other terms it’s not stable, which is Ukraine.
Jones: We continue to look at new markets for the expansion of our network. At the moment, we see North and South Africa as offering many exciting opportunities. In some markets derivatives will be emerging or will be allowable, exchange-traded funds, and third-party clearing in the markets as that roll-out is allowable. And securities borrowing and lending will be possible in some markets where it was not allowed previously. From the client perspective, we’re investing heavily in our client information reporting and ultimately trying to eliminate some of these inquiries altogether by giving the customer better reporting—before it’s required—and making sure it’s consistent and accurate.